A capitalization-weighted index explicitly links the weight of a holding to its price, so the more expensive a stock gets, the bigger its weight in your portfolio, says Research Affiliates' Rob Arnott.

Exchange - tradedfunds seem to encourage myopia. As the variety of ETFs widens, the individual funds themselves are narrowing. Most of the new ETFs launched in recent months have been sector or industry funds that hone in on ever-thinner slices of the stock market, such as home builders, oil ...

A Rough Road for Financial-Services ETFs

In the first half of 2014, the market performance of the U.S. financial-services sector trailed the broader U.S. equity market by several hundred basis points.

Thus far this year, there have been some small bumps in the road for a sector that has enjoyed a robust comeback during the past five years, but where volatility remains meaningfully high and uncertainty even higher. While no one doubts that large banks, which dominate the financial sector, are far better capitalized than they were heading into the financial crisis, the final results in March of the Federal Reserve's annual stress test on the United States' 30 largest banks demonstrate both a lack of robustness on the part of some large lending institutions--including CitigroupC--as well as the clear presence of a prominent headwind in the form of elevated compliance, regulatory, and legal costs across the industry.

Another headwind is the U.S. economy. While it unquestionably has shown some bright spots during the past several years, concerns about a less-than-strong economy generally has weighed on banks, which feel less inclined to lend in such an environment. Less lending means less growth for banks.

The Opportunity in U.S. Financial ServicesMorningstar's equity analysts view the financial-services sector as largely fairly valued, with pockets of opportunity in individual stocks. A future rally in the sector likely would be driven by several factors, including continued improvement in the U.S. economy (and likely, overseas economies as well), which would in turn prompt central banks to continue pulling back on their "easy money" policies and instead allow for interest rates to rise. That likely would mean greater lending from banks, as well as lower global unemployment. At the same time, global markets would need to continue their march upward (Morningstar's equity analysts hold the view that the financial-services industry's asset managers' performance more or less will follow the market). And, in theory, continued strong markets would bring more deal activity for investment banks. On top of all this, banks likely would continue their ongoing cost-cutting efforts (we view many physical bank branches as endangered species).

Unpacking Specific Subsectors' PerformanceBroadly, the financial-services sector breaks down into a handful of subsectors, which include banks, insurance firms, REITs, and asset managers/capital markets. Banks have underperformed the overall U.S. equity market thus far this year, amid stress-test results and a general sector rotation away from financial services. Insurance firms also have lagged amid strong debt and equity markets, which tend to force down insurers' prices and thus returns on invested capital. Meanwhile, REITs have done very well after a not-so-great 2013, during which investors panicked. Although one might think that the specter of rising rates would hurt REITs, rising rates also usually mean a strong economy, and for REITs, a boom means higher occupancy and steadily increasing rents on tenants.

A Closer Look at an Array of Financial-Services ETFsSome of Morningstar's own proprietary data points can help investors make sense of the many exchange-traded funds out there that are devoted to the financial-services sector. First, we will apply some of these data points to a group of broad-based, market-capitalization-weighted financial-services ETFs. Next, we will take a closer look at strategic-beta financial-services ETFs, global and foreign financial-services ETFs, and the narrowly constructed ETFs devoted to several financial subsectors. Finally, we'll examine recent trends in fund flows in the financial-services sector.

An Overview of Market-Cap-Weighted Financial-Services ETFsThere are three large and liquid cap-weighted financial-services ETFs: Financial Select Sector SPDRXLF, Vanguard FinancialsVFH, and iShares U.S. FinancialsIYF. All seek to replicate broad indexes of the largest U.S. financial stocks, including diversified financial-services companies, banks, REITs, insurers, and capital markets firms. All have relatively similar portfolios, although there are small differences in composition.